Economic 'fertilizer' buried in tax plan will spur growth

Economic 'fertilizer' buried in tax plan will spur growth
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In the noise around the tax plan, one topic that is not being discussed much may seem boring at best, but it may end up being one of the largest levers of growth for the economy.

Both House and Senate plans offer expanded ways for businesses to save money on purchasing equipment and other business investments. Assuming the compromise bill keeps these changes, this will be very beneficial to small business owners, who create up to 60 percent of new jobs and most of the innovation in our economy.

The plan should drive increased investment in the economy and therefore have cascading positive effects on growth. Here’s how: 

Today when you own a small business and buy a new piece of equipment, you are allowed to “depreciate” half of that investment in the first year and the rest over five years.

So for example, if you buy a piece of equipment for $100,000, you can deduct a $50,000 depreciation expense for it from your reported business income the first year, and then $10,000 each year for five years. (There are deductions, as well, allowed for specific business investments under Section 179 of the tax code, and those are geared to benefit the smallest businesses.)

Under the new tax plan, you’re going to be able to deduct the entire $100,000 the first year (a $100,000 investment divided by a 1-year depreciation schedule). So, in today’s tax code/scenario, if your business is making $200,000 in profit, you can expense $50,000 in depreciation and your taxable net income is then $150,000 ($200,000 less $50,000).

Under the proposed tax plans, your taxable income will be $100,000 ($200,000 less $100,000 in depreciation expense). As a result, your taxes that year should be lower, so in effect, the equipment has a lower cost up front. 

Both the House and the Senate plans allow this 100-percent expensing for certain purchases made during a limited window of time. In addition, the new tax plans would increase the Section 179 deductions allowed for certain purchases. So this, too, would help small companies cut the costs of their investments.

Why is this such a powerful fertilizer for the economy?

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First, tax incentives create jobs. When businesses buy a computer, they usually buy a computer for a person. When businesses buy a tractor, they need to put a person on the tractor. When businesses buy a building, they usually put people in the building.

 

So, when you give small businesses a way to cut their cost of investments in these things, they are more likely to make those investments, which indirectly helps job growth, at the minimum.  

For example, if a business has one forklift and one worker, and you incentivize the business to buy a second forklift because the cost will be lower through tax deductions, we know that the small business will gain from the tax write-off.

This may make it easier for them to hire the second worker to operate the second forklift in order to service more sales and grow the business.

We also know that there’s probably a company building that forklift, so that company’s revenue is going to increase. This usually increases the long-run need for workers at the forklift manufacturing company.

To a business owner, this is common sense. If I’m going to go out and buy a piece of equipment and I can write off a substantial part of that, I’m going to buy more stuff. Whenever businesses are buying more things, it usually means that people are needed to run those things.

Second, the buying spurred by these tax incentives will create more efficiency. By purchasing the extra forklift, the business can either produce more and grow its revenues or decrease hard-capital-related costs, so there’s long-term benefit in addition to a short-term gain.

Most businesses aren’t adding jobs or purchasing equipment for the benefit of mankind. They’re doing it because they want to grow, and they know that in order to grow, you have to invest in technology, things and people. The tax plans under consideration would encourage businesses to invest more.

In economics, it’s not always true that for every good there’s a bad, but the cost of these incentives will likely be increased deficits. This is a fair complaint. However, helping small businesses is a good thing because they create the most value in the economy.   

Brian Hamilton is an entrepreneur and the founder of Sageworks, which provides financial analysis solutions, industry data and risk management solutions for private company CFOs, accountants and bankers. He's also the founder of Inmates to Entrepreneurs which aims to reduce the rate of recidivism by providing an alternative path to financial stability and success. He is a regular guest on CNBC and MSNBC and a contributor to Inc. and Entrepreneur magazines.

Mary Ellen Biery is a research specialist at Sageworks.